The Demise of the Overhead Myth: Administrative Capacity and Financial Sustainability in Nonprofit Nursing Homes

• Published date: 01 May 2021
• Author: Young Joo Park,David S.T. Matkin
• Date: 01 May 2021
• DOI: http://doi.org/10.1111/puar.13269

Research Article

The Demise of the Overhead Myth 543

Abstract: In the study and practice of public administration, it is often assumed that higher levels of budgetary

support for non-program expenses, such as administrator salaries, accounting, grant writing, and marketing,

are evidence of inefficiency and wasteful spending. As such, grant makers and researchers often use the ratio of

organizations’ administrative to total costs to measure the efficiency of public services. While this perspective has some

validity, it also significantly minimizes the effect of administrative functions on sustainability, an important aspect

of long-term performance in public service organizations. We use standardized cost data from a 14-year panel of

approximately 3,000 nonprofit nursing homes and find an inverted U-shaped relationship between administrative

cost ratios and financial sustainability, which suggests a “sweet spot” in the level of administrative support that tends to

promote organizational sustainability. This sweet spot occurs when administrative costs are about 40 percent of total

organizational costs.

Evidence for Practice

• This study provides strong evidence against limiting support for administrative functions to levels commonly

viewed as desirable by most nonprofit monitoring groups. Rather, the results suggest a sweet spot of about

40 percent of total spending on administrative functions to maintain a strong financial position.

• Nonprofit sponsors and advocates should recognize that current standards for optimal spending on programs

are likely to greatly constrain the sustainability of nonprofit organizations, potentially crippling their

effectiveness over time.

• Financial sustainability can be seen as akin to management capacity and, thereby, should be recognized as an

important performance objective.

Public administrators face potentially

severe criticism when they allocate scarce

organizational resources toward functions such

as accounting, marketing, and human resources (i.e.,

overhead or administrative functions), which indirectly

support their organizations’ core missions rather than

directly strengthening their programs and services.

This criticism is especially common in nonprofit

organizations where costs are closely scrutinized

by grant sponsors, contractors, donors, service

recipients, and watchdog organizations (Frumkin and

Kim2001; Keating and Frumkin2003). Nonprofit

leaders often respond to this pressure by starving

their organizations’ administrative infrastructures in

order to report higher relative levels of programmatic

spending to gain a competitive advantage over other

organizations in the pursuit of financial resources

(Gregory and Howard2009; Lecy and Searing2015;

Wing and Hager2004).

It is not surprising that nonprofit stakeholders favor

spending on programs over central administrative

functions. After all, the very existence of the nonprofit

sector is frequently justified by its ability to provide

public goods and negate market failures. If we

compare multiple nonprofit organizations with

similar performance records, those organizations

that spend more on administrative functions may

reasonably be viewed as less efficient. On the other

hand, some minimal level of general administrative

capacity is obviously necessary in order to sustain and

support effective service provision, so an excessively

frugal approach to administrative infrastructure will

eventually harm organizational performance.

Despite the significant pressure on nonprofit

managers to prioritize programmatic spending over

administrative functions and the important role that

administrative support plays in the sustainability

of public service organizations, there is limited

empirical research into the relationship between

levels of spending on general administrative functions

relative to overall spending (i.e., the administrative

cost ratio) and the financial sustainability of public

Young Joo Park

David S.T. Matkin

The Demise of the Overhead Myth: Administrative Capacity

and Financial Sustainability in Nonprofit Nursing Homes

University of New Mexico

Brigham Young University

Public Administration Review,

Vol. 81, Iss. 3, pp. 543–557. © 2020 by

The American Society for Public Administration.

DOI: 10.1111/puar.13269.

Young Joo Park is an assistant professor

in the School of Public Administration at

the University of New Mexico. She studies

public financial management with particular

focus on financial condition analysis,

nonprofit finance, and health care finance.

Email: park@unm.edu

David S.T. Matkin is associate professor

in the George W. Romney Institute of

Public Service and Ethics at Brigham

Young University. His research focuses

on the financial management of public

service organizations, especially financial

accountability, public pensions, and debt

management.